BAD DEBTS & ALLOWANCE FOR

DOUBTFUL DEBTS
Lecture-10
Bad Debts

“A debt which is not expected to be recovered is called Bad Debt.”

A credit customer might fail to pay;

 out of dishonesty

 because of going bankrupt

 unexpected restriction from foreign governments

 any other reason

Direct write-off method
Writing-off a debt:-

At some point after giving due consideration to circumstances, cost of

trying to recover the payments and possible court costs, when a
business decides to give up expecting payment the debt is “written off”

Following entry is passed to write off a debt:-

Bad Debt Expense A/C xxx

Accounts Receivable A/C xxx
Direct write-off method

Recovery of Bad Debts:-

A written off debt might occasionally and unexpectedly be paid by the
customer. In that case we have to record the payment but there are two
different scenarios;

1. Recovery within the accounting period in which debt was written off

2. Recovery in one of subsequent accounting periods.

In both cases first step is to reinstate the receivable and second step
is to record the cash receipt.
Direct write-off method
Recovery of Bad Debts:-
Recovery within the
Recovery in subsequent periods
accounting period
Step 1  Reinstating Step 1  Reinstating
Accounts Receivable A/C xxx Accounts Receivable A/C xxx
Bad Debts Expense A/C xxx Recovery of Bad Debts A/C xxx
(reversal of the entry passed to write-off the (writing-off entry cant be reversed because Bad
debt) Debts expense is a nominal account and would
have been closed so recovery of Bad Debts A/C is
opened which is shown in other incomes section of
Income Statement)
Step 2  Recording cash receipt Step 2  Recording cash receipt
Cash A/C xxx Cash A/C xxx
Accounts Receivable A/C xxx Accounts Receivable A/C xxx
Provision/Allowance for doubtful debts (Allowance Method)

 Faithfull representation in accounting is a concept which requires

the financial statements to accurately reflect the condition of
business.

 Substance over form concept also emphasizes on recording the

economic reality of transactions rather than strictly legal form.

 Prudence concept also require to record liabilities and expense as

soon as they are foreseeable but revenue must only be recognized
when they are realized or assured
Provision/Allowance for doubtful debts

 According to matching principle of accounting the expensed

incurred during an accounting period should be matched (subtracted
from) the revenue that was earned during same period.
“Under direct write-off method it is quite possible that revenue through a credit sale
may be recorded in one accounting period and receivable becomes uncollectible in
a later period”
Provision/Allowance for doubtful debts

The direct write-off approach is followed by small businesses which

don’t rely heavily on credit sales. because for businesses with large
credit sales It is almost impossible to determine how much of its
accounts receivable will become uncollectible. So, on the basis of past
experience a provision for doubtful debts is created which is contra-
asset to accounts receivable.
It can be calculated by;
1. Percent of credit sales method (Income Statement Approach)
2. Ageing Analysis (Balance Sheet Approach)
Provision/Allowance for doubtful debts

Percent of Sales Method (Income Statement Approach)

On the basis of past experience the amount of credit sales for an
accounting period is multiplied by an estimated percentage to determine
the provision for doubtful debts.
e.g. Over last several years Mr. A has noticed that 5% of accounts
receivables from his credit sales become “Bad”. So at the end of
accounting period he will multiply is annual credit sales amount with 5%
to determine the provision for doubtful debt amount.
Provision/Allowance for doubtful debts

Ageing Analysis (Balace Sheet Approach)

It is well known that the longer a debt remains unpaid, the more likely it
is that it will become “bad”.
Some business draw ageing schedule as illustrated to determine the
provision for doubtful debts.
Ageing Schedule for Doubtful Debts
Owing period Amount due Estimated %age Provision
Less than 30 days Rs. 100,000 2% Rs. 2,000
1 to 2 months Rs. 50,000 5% Rs. 2,500
2 to 3 month Rs. 200,000 10% Rs. 20,000
3 to 6 months Rs. 20,000 20% Rs. 4,000
More than 6 months Rs. 10,000 50% Rs. 5,000
Rs. 380,000 Rs. 33,500
Provision/Allowance for doubtful debts

Accounting Entries
1. Opening Allowance Account;
Dr. Bad Debts Expense A/C xxx
Cr. Provision for doubtful debts A/C xxx

2. Increasing the provision;

Dr. Bad Debts Expense A/C xxx
Cr. Provision for doubtful debts A/C xxx

3. Decreasing the provision;

Dr. Provision for doubtful debts A/C xxx
Cr. Bad Debts Expense A/C xxx
Provision/Allowance for doubtful debts

Accounting Entries
4. A debt becoming irrecoverable (Write-Off)
Dr. Provision for doubtful debts A/C xxx
Cr. Accounts Receivable A/C xxx

2. Recovery of written-off debt

STEP-1  Dr. Accounts Receivable A/C xxx
Cr. Provision for doubtful debts A/C xxx
STEP-2  Dr. Cash A/C xxx
Cr. Accounts Receivable A/C xxx
Home Task

 Journal entries related to Bad Debts and allowance for doubtful debts

 Preparation of Accounts Receivables and Provision or doubtful debts

accounts